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A year that many experts believed could end with a recession and rising unemployment instead ended with a rising stock market and enthusiasm for the economy as a combination of Big Tech and consumer sentiment catapulted financial markets into 2024.
The S&P 500, a market-tracking index that underpins the retirement wealth of millions of Americans, rose nearly 25 percent in 2023, far more than analysts had expected at the start of the year. “Nobody asked for 20 percent last January. … I mean nobody,” said Michael Farr of D.C.-based investment firm Farr, Miller & Washington.
The Dow Jones Industrial Average surpassed its previous record, gaining more than 13 percent.
But it was the tech-heavy Nasdaq Composite Index, led by a group of elite tech companies called “The Magnificent Seven,” that really impressed Wall Street, rising more than 40 percent for the year. These same stocks bore the brunt of a historic sell-off the year before as the Federal Reserve began raising interest rates, and they began the year cautiously as a recession appeared imminent. Instead, the economy held steady and improved its investment prospects just in time as investor attention to artificial intelligence exploded.
Most of the stock market's gains came in the final months of the year, when a stream of new data seemed to confirm once and for all that the Fed's goal of a “soft landing” – shorthand for lowering inflation without destroying the economy – was succeeding could be in sight.
The recession that didn't exist
Since March 2022, the central bank has continuously raised its key interest rate to its highest level in 22 years, now at 5.25 to 5.5 percent. Higher interest rates suppress inflation because they force consumers and businesses to cut spending, the theory goes.
Ultimately, inflation fell, but the interest rate hike campaign also came with costs. New mortgages became less affordable, excluding many from homeownership. Companies that relied on loans had to scale back their expansion.
Some investors remained concerned that the central bank would go too far with its interest rate hikes and slow the economy too much in its eagerness to cut prices. 2022 saw repeated market sell-offs as investors anticipated the Fed's moves. Among the worst losses was the technology sector, whose riskier, growth-oriented business model makes it more vulnerable to shocks and even small changes in interest rates. The Nasdaq index lost a third of its value.
Heading into 2023, analysts saw a 65 percent chance that a recession would occur that year, according to a consensus estimate cited by Goldman Sachs.
Instead, the latest economic data suggests that higher interest rates are having the desired effect on inflation, without the worst side effects. Inflation fell faster than expected and stood at 3.1 percent in November. That's a far cry from its peak of 9.1 percent in June 2022 and within sight of the Fed's 2 percent target. (The Fed's preferred inflation indicator was even lower at 2.6 percent in November compared to a year earlier.)
The labor market has now weakened without a crater. Overall job growth slowed from an average of 240,000 new jobs per month to 199,000 in November, while the unemployment rate was 3.7 percent that month. In fact, the unemployment rate has been below 4 percent for two years, a level last seen in the 1960s. As of Thursday, about 212,000 Americans were filing new unemployment claims each week, a widely watched indicator of layoffs that remains near historic lows.
Consumer spending has also held up. New data from Mastercard released Tuesday showed that despite rising consumer debt and persistent inflation, Americans weathered the holidays well, with online spending rising 6.3 percent.
Even the global banking crisis that rocked markets in March and April after a bank run forced Silicon Valley Bank to close failed to trigger a broader collapse of the financial system.
Dan Ives, senior analyst at Wedbush, estimates that around 50 percent of the tech sector's gains in 2023 can be attributed to the Fed's success in controlling inflation – which in turn has raised expectations that the central bank will cut interest rates in 2024 becomes.
The other half reflects investors' search for AI-related opportunities, creating “a perfect storm for the tech bulls,” Ives added.
The year began with mass layoffs.
Amazon cut around 27,000 jobs and cited an “uncertain economy.” Google's parent company, Alphabet, announced in mid-January that it would cut around 12,000 jobs, more than at any time in its history. CEO Sundar Pichai said the company was “hiring for a different economic reality than the one we face today.” ” Microsoft cut 10,000 jobs after Chief Executive Satya Nadella warned that consumers were cutting spending and corporate customers were bracing for a recession.
(Amazon founder Jeff Bezos owns The Washington Post, and the newspaper's interim CEO, Patty Stonesifer, sits on Amazon's board.)
The reason for the cuts was a perception on Wall Street that the biggest technology companies were bloated, profit-making behemoths with questionable growth prospects, similar to the railroads or steel companies of decades past, said investor and stock trader Tom Essaye, founder of Sevens Report Research.
Additionally, tech companies “built aggressively in 2021 and 2022, and the demand they thought they were building for didn't materialize,” said Mark Mahaney, senior managing director of Evercore ISI.
However, during the year, demand for these companies' services such as advertising and online retail held up better than expected, Mahaney noted, while their balance sheets were strong after a season of cost cutting. A subsequent spate of healthy gains brought investors back into the technology sector.
Against this backdrop, the AI boom brought big profits to some leading companies and led to a literal rebranding of the leading technology companies. These heavyweights are now known as the Magnificent Seven: Google, Meta, Apple, Amazon, Microsoft, Tesla and the newest newcomer, Nvidia.
Nvidia was one of the biggest AI winners after revealing in May that one of its computer chips had trained ChatGPT, the AI language model that has impressed users with its ability to solve problems and imitate human speech. The company's stock price skyrocketed on the news, rising more than 230 percent since the start of the year.
But it's not the only technology company that has ChatGPT and its inventor OpenAI to thank for massive share price increases. Microsoft, which invested $10 billion in OpenAI in January, has seen its shares rise more than 50 percent this year – up 13 percent in the month alone after first reporting its OpenAI investment.
Some analysts believe the attention being paid to AI has already changed investors' broader view of the tech sector, even among companies that don't offer AI-enabled products.
“Artificial intelligence represents a new potential growth frontier for these companies,” Essaye said. “Regardless of whether your company benefits from AI, there is a positive market reaction. That’s it, and they’re jumping at it.”
How quickly these investments will bear fruit is another question. ChatGPT wowed the world with its ability to mimic human speech and thought patterns, but the business case for the future is less clear, Essaye noted.
With technology, “the evidence needs to be visible,” Essaye said. “And because [the Magnificent Seven] are such a large part of the S&P 500 that when they start underperforming, they act as anchors in the market, regardless of what else happens.”
Eli Tan contributed to this report.
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